Grocery Outlet Holding Corp. (GO) Earnings Call Transcript & Summary

Good afternoon, everyone. Thank you again for joining us today at the Goldman Sachs 28th Annual Global Retailing Conference. I'm Kate McShane. I'm the Hardlines Broadlines and Grocery analyst here at the firm. And we're very pleased to introduce the members of the management team for Grocery Outlet. We're going to be conducting this session as a fireside chat, but I'm going to quickly turn it over to Eric Lindberg, who's going to introduce the team that's with us today. Thanks, Eric.

Awesome, Thanks, Kate. First off, thanks for inviting us. Happy to be here today in a virtual world presenting to you guys. So I appreciate the invitation. We're excited to talk about the business. To your left, Charles Bracher, our CFO; to your right, RJ Sheedy, our President; and I'm Eric Lindberg. We're here today in Emeryville at the headquarters for Grocery Outlet and excited to kick it off. So thank you.

Great. Thank you. Thanks so much for joining us today. I wondered if we could start off kind of higher level. Grocery, I think the sustainability of the category has surprised everyone. I think it was a year ago, around this time, where we had started getting questions from investors about the sustainability of grocery demand as the world opened up. And I think the unwind of eating at home has been much slower than a lot of people anticipated. So I wondered if you could talk a little bit about just that trend and what you expect to see going forward as a result of what we've just lived through and what you see in terms of what's sustainable consumer behavior and what might change over time?

Yes. I will. Let me just step back for a second. I want to make sure I give you guys sort of what we're going to be talking about today and just reference that the trends we'll talk about are just going to be what we've seen sort of through the second quarter, what we discussed on that call and making sure you guys know we're not talking about sort of a mid-quarter update. I just want to get that out on the table as a reminder. It's a great question, Kate, on sort of consumer trends, what's sustainable, what's going to change. We don't have a grand crystal ball. We think that just to revert back to food, I think food at home was a good experience for people in COVID, a lot more experimentation, perhaps some realization, cooking, spending time with family, realizing that the home is a core asset for all of us and being able to sort of connect food to experience with family. I think those are all great trends. I think there was a real rush to get back out to your favorite restaurant or to just have the experience outside of the home. If you saw that shift from sort of 50-50 to sort of 80-20, food at home to food away from home, that shift came back, at least what we saw in our markets pretty radically in June of this year as people were sort of let out and they can sort of go experiment. I think what will happen is the reality for most people is that eating out after what the restaurant industry has gone through is very expensive, everything. Labor is up, food costs are up, supply chain costs are up. And so the pricing transition over to the consumer from pre-pandemic to post-pandemic is pretty stark. We've been talking about it for a long time. I think we've all personally witnessed that. Yes, I think the trends as we look forward to '22 and '23, I think the food at home is really strong, and I think that probably addresses what you saw some of your questions around the sustainability of the category. I think the way that manifests will be different. We love our positioning, small stores, efficient stores, neighborhood stores, local stores, addressed by local people, a lot of variety, a lot of selection, a lot of value. We think those are all sort of enduring and sustaining for future decades. But we have to be cognizant that people find the convenience of delivery and the convenience of being able to hit a button and get product at your front door is pretty enticing, particularly given that we're all going to be spending more time at home working, which is a big difference to pre-'19. So open up to these guys for any other additional observations or thoughts.

I think you covered it well. Yes, nothing to add.

Maybe if I can ask a question within that. You mentioned that the digital piece is something that consumers are looking for, when I think Grocery Outlet, I think a lot of value. So could you maybe talk about the role of value in the consumer's life, how maybe that's been changing and what you've seen more recently in terms of trends when it comes to that customer looking for more value?

Yes. So I think relative importance for us, most of our consumers are seeking value and have for literally decades of Grocery Outlet, we've become -- we've sort of known and ubiquitous for delivering the best value in food in the environment we've been delivering that for years. I think what happened is that temporarily got dislocated as people sort of put safety and the importance and the intentionality of one shop over go hit my 5 or 6 stores to sort of build the basket of things I'm going to take home. We definitely saw that. We saw a trip consolidation. We saw the importance of safety and our survey were overvalued. We've seen that sort of come back as people have gotten comfortable, very comfortable with the environment that we produced inside the store for safety and sort of all the COVID treatments that we've done inside the store. But I think the relative value being the top of the list, it's not quite there yet. I think it will revert. I'm not sure we don't have the crystal ball as to when, but we think it does come back. And yes, that's what I'd say.

Okay. That's helpful. I think when you were here last year at our conference, you highlighted the amount of new customers you were seeing as a result of the pandemic. I wondered if you can update us now on how sticky those particular new customers have been? And what do they look like versus your more mature customers?

Yes. RJ, do you want to?

Yes, sure. So we did attract a lot of new customers last year and we continue to see new customers shopping our store. To your question on what do they look like. I'd say the profile is similar to as it's been, looking back a number of years, which is it's quite broad, speaks to the broad appeal of the model, this value-minded customer, bargain-minded customers, stands lots of different demographics, certainly different levels of income at the lower income levels, more of a need there to save money. And then at the higher income, think of those more as the want, right? It's just the desire to save money and get a deal. Customers shop us in a lot of different ways. We have a healthy segment of our customer population where we serve as the primary store. So it's the weekly or even more frequent than that shopping trip and they're buying the majority of their food at home with us. And then it spans all the way then to those that are shopping us as more of an occasional trip, and we fill that role relative to other places if they're shopping, but we're a smaller percentage. So those characteristics and that breadth has been very consistent in the new customers that we've seen. Stickiness is there we know from customer surveys. So the experience is a positive one. They love the value. They love the treasure hunt. That's the ever-changing assortment. They love NOSH, our natural and organic assortment. They love the quality of the products that they see if they're new. Many of them may not have expected to see the quality together with the industry-leading lower prices. They love the connection with the community. All these unique attributes a combination that is what we call the WOW! shopping experience. So that all is resonating. We don't have specific customer identification or tracking at POS. So don't have more specific data to share on percentages that have stock in those sort of -- and how often they've shopped in the conversion, that is a future for us. So we're very excited about what we call personalized marketing, so tracking that, understanding what they buy and then what else they might buy and how we better communicate the deals that are in the store to them to increase that stickiness. We do -- when new customers shop us digitally, we're communicating with them. We have a welcome series e-mail campaign that we put out to educate them on the model. And then together with the WOW! Alerts and the digital weekly ads, operators are very active on social media. So there's a personal grassroots connection that they have to their community into those new customers. And in most cases, they're interacting with them in the stores, and they're educating them on the model, helping them find products and then together with the great items and values they see. So all of that feels good. Fundamentals of the business are healthy. All of these unique attributes are resonating, and we think that positions us well for continued growth in our loyal customer base.

So in the context of that kind of taking my last 2 questions and combining it a little bit more into what occurred during Q2. What do you think is happening within the competitive landscape more recently? And do you think you have an opportunity to take some more share in the back half of this year?

Yes. It's -- we've seen pretty competitive Q2 activities from other retailers. I know nationally, we look at the same thing that you probably look at. It's still not as high as '19, but relative to '20, it's higher. I think recently, like in the last couple of weeks, we've read probably similar reports that we've all seen, and that is that it's actually coming back a little bit, that it's getting less competitive. People are starting to take price and promote a bit less. A few public statements of that same thing and sort of the premiumization and sort of taking customers up because they have the disposable income or the affordability. I think that could play out as inflation sort of rolls through manufacturing, roll through production, rolls through to retail, and retailers are forced to take prices up. I think you may see people pull back a little bit from promotion. Relative to GO and taking share, I remind people that we're not a very promotional retailer. The price that we set is the price that we have, and that's the 40% savings traditional, 20% savings to discount. And that's always been the price that sort of gets people very intentional about coming in and shopping. So we've gotten that reputation, whether it's from basket or item level, or the percent of the basket that's really high 50%, 60%, 70% save up to. That's been the hook to get people in to come and shop at the store. We use very, very small parts of our business to sort of tell people about whether it's a radio ad, we tag an item or it's something on digital or Facebook or something local that an operator uses to go on to some of our e-mail that we call WOW! Alerts, we can take a very small subset of the assortment and use that as a hope to get people in. And those are pretty traditional items that sort of people respond to. But relative to the overall nature of Grocery Outlet, we're not print advertisers. We don't do any print. We do everything digitally, promotional environment for us. It's not 30% or 20%. It's not even measured probably in double digits. It's probably more like 3% or 4%, our basket is truly promotional. So our ability to take share is you have to think about the relative positioning of GO in any one of our markets. 3%, 4% share is sort of the size that we punch at. So any movement we could make in gaining customers is going to be meaningful customer share gains. So for us, we think that's a huge opportunity, particularly as we move into next year, we start thinking about putting more resources and energy into personalization where the consumer is going, where they already are, we're already working on. We think that will be a meaningful ability for us to grab some share in 2022.

Okay. And you mentioned inflation. And I think actually on the last 2 conference calls, when it's come up, you've talked about having an opportunistic and flexible model that shields you from a lot of the inflation that you see in the environment compared to traditional grocery. So could you maybe help us understand how the raw material and transportation-related cost issues have helped you? And how you are able to mitigate that?

Yes. So a little bit on the model and how we're able to navigate inflation first. So we do business and in any given year, we're doing business with thousands of different suppliers. And so between suppliers, between items, it's just a natural part of how we manage our assortment. And it's understood and expected and welcomed by consumers. And so this change within the assortment is just how we operate and how the customers experience product at Grocery Outlet. So in an inflationary environment, first course of action will be to bounce between suppliers, and on the everyday side, bounce between items and that's, again, part of normal course of business within every day. So we always want to represent a category or a type of item, but we're less specific on the brand or rigidity within the hierarchy as a conventional supermarket might be. And so it's a big way that we're able to navigate inflationary pressures. Pricing, very dynamic, real-time pricing in this model. So we're pricing items today as we're buying products for what will be in the store in matter of days or certainly the weeks ahead. So very, very flexible from a pricing standpoint, together with cost pressures. First and foremost, we're pricing to the value. So we talked about the 40% basket savings to conventional, 20% to discount. We want to maintain that value. We have a number of other ways that we measure value, making sure that we're representing a healthy percentage of our assortment that's at 50% or higher save up to, paying very close attention to commodity items, making sure that we're priced right there at or lower than the lowest discounter in our markets. And so -- but within that, we're able to have quite a bit of flexibility, and we do manage pricing and margin and value altogether and so it serves us another way for us to mitigate some of those pressures. On the freight side of the business, a lot of our outbound freight is controlled, managed through our own fleet. So it's helped us there to some extent. But look, yes, we feel the pressures of inflation. We're not completely isolated or immune to it. And so as we talk about margin, something we'll continue to manage. But we've got a long, I'd say, very successful track record in managing margin. Ultimately, for us, the goal here is to maintain and we have general consistency in margin through the model, through pricing, through some of the things that we control. And even in an environment like this, we feel pretty good about our ability to continue to do that.

Okay. I was curious to ask a little bit about the closeout product that you sell. I know during the pandemic, there was a little bit of a concern about whether you'd be able to get the closeouts and you ultimately were fine because there were so many outlets, I think, looking to do closeouts. So could you maybe talk about the environment right now for closeouts and procuring that inventory? And just how you think about it longer term?

Yes, sure. So our pipeline is healthy. We feel really good about availability of opportunistic supply. We -- yes, last year was a big shock to the system. Supply chain disruption continues to be prominent in many conversations. And we've always said, Kate, supply chain disruption is a good thing for this business, right? And opportunistic supply exists for lots of different reasons. Certainly, just general demand supply imbalances, yield product. You mentioned last year we saw some suppliers come our way that previously were foodservice looking for outlook for products. So that was -- those were nice relationships formed that continued. We've seen now more recently this year, some of the output from excess capacity and production that suppliers have invested quite a bit of money in. And again, maybe not quite being in sync with demand. It's been a really hard year to forecast demand. And so many suppliers' production in certain instances has been ahead of where the demand is. Innovation has come back online. So there was a little bit of a pause with some suppliers last year. Companies need to innovate to grow. So we've seen that definitely kick back into gear and again, resulted in products. And then longer term, in terms of product that's available, innovation will continue. This move to fresher product continues, shorter shelf life and again, less room for error on forecasting and production, requests from other retailers for exclusive lines, something that we benefit from when there's changes made, branding, packaging, you name it, there continues to be a lot of reasons why opportunistic supply exists. We're a big player in this space, but we have a lot of room to grow. It still is very, very fragmented. And so the pool or the pie is growing for all those reasons that I just mentioned. And we have and we will continue to gain share. And we're very intentional about the way that we do that, right? We are a partner to the suppliers we do business with. We help them with solutions to some of their excess inventory challenges. And increasingly, we also represent a very attractive primary sales channel for them. And so we found great success in blending every day with opportunistic and thinking about the business and the opportunity suppliers and grocery outlet more holistically and longer term. And that's served us really well. So yes, just a lot of good things happening within the opportunistic supply world, and plenty of product there to continue to support our growth plans.

Would you say that is -- your supply chain is -- I'm sorry, my light goes off if I don't move. Would you say that your supply chain and your ability to procure this inventory is probably the area of deepest competitive moat, if you will? And if not, where would you point to within Grocery Outlet's model that you think is the competitive moat for your company?

Yes. We -- anyone can chime in here. We think it's a pretty big moat. And it's one that we -- as I said, we're very intentional about it. We think it's one of the best investments we can make into the business, which is the whole buying process, right, the relationships with the suppliers, the systems that we use to manage and write POs and then take product in. The degree to which we are flexible and agile is a really big advantage. We're taking multiple tens of truckloads of product at any given time, all the way down to partial truckloads pallets, right? And we can move it through the warehouse, we can send a direct to store. And so the degree of flexibility with which we manage the business is, yes, it's just hard for other companies with more strict policies on the supplier side or more fixed hierarchies within the assortment to try to replicate. And so yes, there's definitely a degree of competitive advantage there. And then I'd say, just extend that through the rest of the business, the way that the operators order product, the way that it's merchandised in the store, the way that we pay invoices, everything in this business is built around this opportunistic model in a very seamless and flexible way. So it's a really big one for sure. I'd also put right next to that, though, the operator model. We talk about the buying model and the operator model as being the 2 pillars that really differentiate us. And you provide this incredibly unique combination of deep, deep value and great customer service with this local connection as well, you just don't -- I don't think you see anywhere else in retail. And so I put that up there right there with it. But it's really the integration and combination of those unique aspects across the entire business, I think that differentiate us the most.

I wanted to ask a couple of questions around the IO since they are so important to the model. I think one of the bigger challenges that you're seeing across the board are labor-related issues across all of retail. And I wondered if you could speak to any challenges that the IOs might be experiencing on that front and how they're mitigating it?

Well, it's all true, Kate. We can confirm and we are feeling the same thing here nationally in headlines every day. It's pretty tough out there. I would say, our average operator is running 75% to 80% of capacity in terms of who they'd like to be in their store versus what they actually have in terms of headcount. And that's pretty significant, which puts pressure on the operator couple. They're working more hours. They're making decisions over what they're going to do, what they're not going to be able to get done. And so long term, that's not great. Short term, there's a benefit on the labor line that they get some leverage on financially. They're on the heels of a very good financial year. Last year, COVID did a lot for a lot of people, including our operators from a balance sheet and putting cash in their accounts and sort of giving them some financial flexibility. But it was a really tough operating environment with sort of the on-again, off-again mask mandates, sort of everything went along with the safety protocols. It was a very difficult operating environment. You got -- this year, the operating environment started to stabilize and we got into the spring and labor starting to rear its head and sort of another challenge. We've been dealing with increased labor rates across the West for 5, 6, 7 years, sort of starting in the $9, $10 rate up to what effectively is probably more like $16 or $17 an hour because the minimum is at $14 or $15, but no one's going on and starting at those rates. So we've been dealing with that point effectively. But I would say, it's stressful for operators to have to make those decisions of just working more hours and slogging away versus being able to find people that are talented and qualified and interested in working at a rate that's reasonable and affordable for the operator's P&L. So we're very sensitive to it. The best thing we can do is drive gross profit margin dollars to the store, drive innovation, drive product, support with marketing, create efficiencies in process which we're always working on and continue to invest in. And the operators recognize the efforts and they recognize that they would play back to us. This is temporary. It's got to revert back. People can't live on stimulus forever. Government can't continue to pay at these kinds of levels. So just a matter of time before it comes back. Written article this morning, one of the states that have revealed that June saw a pretty good return to employment rates in July and August. So ours have just shut down. So I would not say it's going to be a light switch that quickly. But I think it will start to come on a little bit more and more into Q3 and Q4.

Okay. Great. And do you feel like some of these challenges are hurting your pipeline of IOs at all? Are there some people who are just like, forget it, this is like too much work? Or is it, again, seen as more transitory and the pipeline is still pretty much the way it looks?

Yes. No, Kate, the pipeline has been strong throughout. We've had a different composition in the pipeline, few are coming from regular retail where prior to the pandemic, there were so many people jumping ship from regular retail because it's effectively not a model that was working. So today, we're still getting a lot of people from regular retail, but fewer we're getting more from alternative channels, which is great, which just sort of puts a little implication on us from a training standpoint to train people differently. But retail, entrepreneur mindset, want to go out and be independent, those are all super high on the sort of attribute list of who we're seeing. And look, I think it's opened up some opportunities for us. The model sells itself. It's so simple to understand, split the gross profit margin on the 4-wall unit 50-50, we make the investment in FF&E. We pay the rent. You pay labor, you pay utilities, you pay business operating costs, local marketing, and you make a lot of decisions. And the outcome is really in your hands, not so much in our hands. We are not controlling that outcome. You're really in charge of what you're going to get tomorrow by what you sell today. So that's really attractive, particularly to retailers, restaurateurs, entrepreneurs that have been running something themselves, but not quite out of the umbrella that we have. So it's really robust. We're getting a lot of people that are interested.

Okay. And then I just wanted to ask a question about unit growth. You have one of the more robust unit growth stories across the retail landscape. And I think you've mentioned in the past that some of the disruption we're seeing in retail could result in some more opportunities for you going forward. So I just wondered what you've seen on this front since we last met with you last September? Can you talk a little bit about how Grocery Outlet is performing in some of your newer markets? And has there been any change in strategy since the pandemic on how you approach filling in existing markets versus new?

Yes, Kate, great question, and I'll try to tick through all of those. But I think referencing back to Eric's response thinking about the IOs. Yes, the new store model is so exciting for both the IOs as well as for Grocery Outlet. We continue to be really pleased with the returns that we're seeing for new stores. And for us, we've been very consistent as stores continue to represent our #1 growth opportunity. So here we stand today at 400 stores. We can look forward, we talked consistently about discipline, 10% unit growth. So we look forward and say, gosh, over the next decade that puts us in 1,000 stores and then continuing to move beyond that. But Eric referenced earlier, the advantage for us, we have a really flexible new store model. It's highly portable. It works across urban, suburban, rural locations. It works across high, low incomes. It works across a range of demographics. And it really gets back to the broad appeal of the value proposition. And so again, for us, we really feel like we can put a store almost anywhere. To your question about COVID-related tailwinds, I would say, to date, no, we have not seen necessarily a marked increase in the number of sites available or a change in economics coming out of COVID and probably a little different than we would have thought 18 months ago, given where the economy is relative to, again, probably earlier expectations. But for us, it continues to be about disciplined growth. So as we talked about new markets, we discussed it as really a crawl, walk, run strategy. RJ referenced the way we have to educate new customers who are new to the concept. So as we go into a new market, it really is about investing ahead of the curve, and that investment is both across sort of supply chain and infrastructure as well as the marketing investment to teach customers who we are, why they should shop us, why we're different. But continue to feel really good about the progress we've made in our newer markets. So Southern California, a market we entered in 2012, brand awareness and productivity and profitability has grown in that market very consistently, and really is now in line with our more mature markets in Northern California and the Pacific Northwest. And then as we look forward for future growth, we'll continue to take that crawl, walk, run approach in the Mid-Atlantic. So it's done some great infrastructure building there under Heather Mayo, and we'll look to accelerate growth in that market going forward.

Okay. There are 4 questions that we are asking every company that's presenting at the conference. We've already touched on a couple of these, but just so that we can get it for posterity. The first question is when you think about consumer demand going forward as we get further away from stimulus, do you expect to see momentum accelerate, decelerate or stay the same through the end of 2021?

Yes. Look, I wish I had that crystal ball, okay? I think we've talked a lot about what we think will create some of those catalysts or more growth for GO. I think the customers are very, very dynamic. It's always changing. We're very fortunate because we're small, we pivot, we're nimble. We're going to sort of lean into some of those opportunities that we see. But short term, next few quarters, I think a lot of our thinking is very much the same. Next year, a big opportunity. Obviously, the comps were off a bit. Some of these trends, I think, will be behind us, some of the transitory nature will be sort of helping us, not hurting us. I think the consumer is going to be looking for value as you see inflation stays around a little longer, and things are very expensive, relatively speaking. And then some of the catalysts around e-commerce, expansion of assortment, marketing message, just sort of the power of the new store model, I think, will start being wind at the back of Grocery Outlet. So -- but again, when that all starts, I'm not quite sure that's beyond our sort of foresight and visibility right now.

Okay. The second question is and this doesn't completely apply, but maybe a little bit, when you think about digital penetration of sales in '22, how would you compare that to what you saw in '21?

Yes. I would -- well, we're starting -- for us, more specifically, we're just getting into digital sales. So we've got this e-commerce test that we're still finalizing to see how it might complement growth potential for us along with what Charles talked about from a new store growth potential standpoint. We're excited about it. We -- it had not been a priority for us at 3%. It's an interesting opportunity for us now at 10%. We think the 10% increases, right? Big, big jump forward because of COVID and it was higher, and it's pulled back a little bit, but we think we're probably at the right level from which we grow 10% industry, I'm talking about and then higher. And then for us, we'll see how it plays in our model. So we're talking about delivery. We're talking about pickup in store. Initial foray won't be any big capital-intensive, direct-to-consumer, we're going to leverage the assets of our -- the asset of our stores and make it more seamless for operators. So we'll learn and we'll figure out, again, how it works in our business unique to us, and one that's a good customer experience online, just like it is in the store.

Okay. The third question is how should we think about promotions in 2022? Will it be higher, lower or the same as 2021?

Again, first of all, I think the environment is definitely changing. I think I answered before, and I'd state that again, I think as people take price, less promotion, perhaps if you see some share loss or some share gain by those like Walmart, Amazon, you may see a little bit more of a reactionary reply from some of the more conventional folks. Certainly, there is a treasure chest that's being accumulated through some of the comps last year. This year, that will enable people to sort of spend against those. So generally, I think '20 was a really profitable year for retailers and manufacturers alike. There's a healthy dynamic between manufacturer and retailer that exists. We'll see how that plays out. The retailers decide that the balance sheet and their partners on the vendor side looks pretty attractive to go rate and put that promotional color behind their, promotional activity. I think that can be a pretty interesting dynamic that plays out as well. So I don't really think it's anyone's guess when you get out into '22, it will really be in the environment. I think that dictates how people react and respond.

Okay. And our last question is, do you expect your inventories to grow faster or slower than sales in the second half of '21?

Yes. For us, again, just recall for our model and opportunistic buying. In general, we've always talked about over the long-term inventory growth should approximate sales growth. But quarter-to-quarter, you can have some fluctuations. It's not necessarily linear because of the opportunistic nature of how we buy.

Got it. Got it. Okay. Well, we're actually at the 1:30 mark. So I want to thank you for joining us today and spending so much time with us. And thank you to the audience for dialing in. It was great to see you.

Thanks, Kate, for hosting. Appreciate it.

Thanks, Kate.

Thanks, everyone.